Subprime crisis: warning signs glaring in 1999!


Representatives from the Office of Thrift Supervision, the FDIC, and banking associations,  symbolically slashing red tape in 2003

While doing some file management, I stumbled on an investment newsletter published in 2001: “A house without equity is rental with debt” by Wall Street analyst Josh Rosner, whose analysis of industry and macro factors turned out to be prescient.

Here’s an overview, and, after that, I’ll briefly contrast it with a 2005 article that wasn’t so prescient, yet was published by a prestigious economic paper…

The 2001 article starts by recalling the industry’s prediction in the late 80’s for the new millennia that the then problematic (for home-ownership? footnote to follow) low savings rate would rise due to a baby boomers effect. By 1999 it became clear that this was wrong: home ownership  increased (from 64% in ’89 to 68% in ’00) not through (1) savings but credit (as measured by consumer debt to liquid assets, from 60% to 96% over the same period). The Fed eased its refinancing rate between 1990 and 1993, such that average mortgage refinancing increased from  $429 bn to $751 bn, a wealth effect that spilled over into other asset classes. However, home-ownership was unaffected.  What unleashed it, was  the Clinton administration’ slashing of red-tape constraining home-ownership for the masses, starting in ’93, which was enacted at different levels of the National Partners in Home-Ownership (HUD, FDIC etc.). In particular, Government Sponsored Enterprises (Fannie & Freddie) lowered down payments for a mortgage loan from 10% (on average equivalent to, in 1998, $12,480) to 3%, and substituted traditional credit reports by ‘automated underwriting’ on an industrial scale (2). Between the 80’s and 90’s existing home sales grew from 30 to 40 million units, and new home sales from 6.1 to 7 million units. In 1999, GSE’s mortg. balances were $2.5 trillion, the size of the “mortg. market” (I guess, ‘underwriting’) was $600bn. Facing the conflicting (an adj. that is implicit in the original, I think) incentives of having to close the deal and maximizing their commission (3), expressed in % of the sale price, RE and mortg. brokers exerted pressure on appraisers to relax their standard a.k.a “hitting the bid”. This resulted in massive fraud, a $120 bn/year industry that was found in a 1999 HUD  audit (for the sake of brevity I am bridging two sources), which was also corroborated by the author’s own survey :Screen Shot 2016-07-22 at 7.35.17 PMFrom here on (pages 13 to 31), our overview of the 2001 article will be broader. It correctly foresaw that continued growth in home-ownership would come through further easing of credit standards—”just the beginning [so far]”, and mentions specifically lobbying of the Office of Thrift Supervision by the America’s Community Bankers. The 2001 article correctly points to the macro-hazard, which was known to the HUD (p. 25), posed by consumer debt (likely to manifest itself if “coupled with a slowdown”). The argument is refined by looking at different types of refinancing (type I, opportunistic, and type II, to ‘smooth consumption’, that is, offset income shocks).

(1) “not through”: my best guess at this paragraph which is not 100% clear to me. (2) With subtle interplay with Private Market Insurance, too detailed to be recapped here.


The other article mentioned in the introduction was published in 2005 , model and empirical based, and titled  “Home-ownership to hedge against rent risk” . Not retrospectively opportune, but also, the authors set out to debunk the “conventional wisdom that housing is very risky”, which sounds a bit like a straw man. Also, there is no reference to debt (contrast the title with that of the 2001 article: “A house without equity is rental with debt” ). A case of the Soviet-Harvard delusion?



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